CHICAGO – Illinois hits the market next week with $250 million of sales-tax backed Build Illinois bonds, its first issue since losing some of their ratings' luster due to the state’s tainted general obligation credit profile.
Ahead of Tuesday's competitive sale, Fitch Ratings affirmed the program’s A-minus rating and S&P Global Ratings affirmed its AA-minus rating. Both rating agencies hit the program with downgrades tightening the link between the Build Illinois credit and the state’s battered GO ratings, and it could face further erosion when S&P releases revised credit criteria later this month.
Kroll Bond Rating Agency assigned a first-time rating of AA-plus. It does not rate the state’s GOs and a state official said the administration of Gov. Bruce Rauner has not decided to add Kroll to its GO rating agencies. Moody’s Investors Service which gives the Build Illinois program the same Baa3 rating as the state’s GOs, was not asked to rate the new bonds.
"The ratings reflect our view of the state's deep and diverse economic base and above-average income levels supporting sales tax collections; very strong debt service coverage; and strong credit structure that we believe largely insulates bondholders from economic and revenue volatility, with an additional bonds test that significantly constrains future leverage," said S&P analyst Gabriel Petek.
The state’s weak general credit quality offsets the strengths, Petek added.
Kroll said its views “the legal framework of the Build Illinois Bonds program, the broad and diverse state-wide economic base which generates sales tax revenues, and the extraordinary pro forma MADS coverage of outstanding senior and subordinate obligations as supporting the rating assignment.”
Kroll’s rating is based on its U.S. Special Tax Revenue Bond Rating Methodology. “The stable outlook reflects KBRA’s expectation that pledged sales tax revenues will continue to grow at a modest pace and coverage of Build Illinois Bond obligations will remain extraordinary,” Kroll said.
With $1 billion in GO borrowing not planned until later in the fiscal year, the deal is Illinois' last ahead of the November 6 election that will decide the governor's and the makeup of the legislature.
The deal is divided into three series for $115 million, $125 million, and a taxable C tranche for $10 million. The fixed-rate bonds are being issued under the junior lien obligation with the first two series maturing in 25 years and featuring a 10-year call and the third maturing in 10 years.
All three are secured by the state’s share of sales taxes but the B and C tranches are further secured by a pledge of the state’s capital projects fund.
Acacia Financial Group Inc. is financial advisor. Katten Muchin Rosenman LLP and Charity & Associates PC are bond counsel.
Rauner’s finance team highlights the program’s strengths in a recorded investor presentation.
“The Build Illinois program boasts a conservative debt profile that is 100% fixed rate and amortizes rapidly” with strong legal protections from a continuing debt service appropriation, strong sales tax collections that provided 27 times coverage last year, and strict limits on future issuance, said capital markets director Kelly Hutchinson.
To issue additional senior lien bonds, collections of the state’s 5% share of its 6.25% tax – with the other 1.25% going to local governments -- must provide 20 times coverage of maximum debt service and 10.2 times on the junior lien. Coverage has ranged from 22.8 times to 27 times over the last seven years. Sales tax collections were $8.7 billion last year.
The state has $2.3 billion outstanding including $1.3 billion under the senior lien and $1 billion under the junior lien and has nearly exhausted the $6.25 billion of issuance authority as $5.6 billion has been sold since the program was launched in 1985.
Build Illinois bonds in the seven to 12 year range have traded recently between 75 basis points to 85 bps over the Municipal Market Data’s top-rated benchmark, said Dan Berger, senior market strategist at MMD. That’s in line with a BBB spread to the AAA that’s currently at about 80 bps on the 10-year. The state’s 10-year GO is trading at about a 180 bp spread.
The 10-year in the state’s last Build Illinois sale for $549 million in August 2016 landed at 1.88%, a 47 bp spread to MMD. A 10-year taxable bond landed at 2.62%, a 104 bp spread to comparable Treasuries.
The bonds remain appealing as a stronger Illinois credit with a sturdy backing, said Brian Battle, director of trading at Chicago-based Performance Trust Capital Partners.
“It’s a sales tax revenue so it’s immune to what’s going on with the budget and general fund issues and the market is smart enough to discern that and likes that the coverage ratios are superior and might not be reflected in the ratings,” Battle said.
Extra yield will also prove a draw as the Illinois name results in a penalty especially among retail buyers. Adding Kroll’s higher rating may not help keep the spread in check but it was a good move as it provides “another data point” for investors, Battle said.
Future risks include exposure to an economic downturn in sales tax collections and the risk that future leaders may dilute the sales tax strengths. The program's authorizing legislation so far restricts its use to financing capital and infrastructure projects.
“In our view, the inability to prohibit future lawmakers from taking such action, combined with the state's unresolved fiscal imbalances, links the credit quality of the Build Illinois sales tax revenue bonds to that of the state's general creditworthiness,” Petek wrote.
S&P dropped the rating to AA-minus from AAA in June 2017 over concerns that the state’s budget woes amplified the risk of potential interference with the flow of pledged revenues. The action came ahead of the end to a two year budget stalemate a month later.
A further S&P hit could loom when S&P publishes its revised criteria for assigning ratings and related credit products to priority-lien tax revenue debt issued by municipal governments, state governments, or other U.S. public finance obligors where the pledged revenue stream is limited.
On Wednesday, S&P released its Advance Notice of Proposed Criteria Change indicating it intends to publish the changes October 22. The state posted a supplement to its offering statement to reflect the report.
“In a prior published statement S&P indicated that it is considering a revised criteria for priority lien tax revenue debt that would formally link the rating on priority-lien tax secured debt issues to the general creditworthiness of the obligor,” the supplement reads. S&P rates Illinois GOs BBB-minus.
Fitch dropped the Build Illinois rating five notches to A-minus from AA-plus in May to reflect its criteria change for state dedicated tax bonds. It assigns a negative outlook.
“In Fitch's opinion, the Build Illinois bond structure warrants a rating two notches higher than the state's [issuer default rating] given the narrowing of the dedicated revenues through the additional bonds tests and the specific nature of the borrowing program,” Fitch said.
